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News February 20, 2012 Issue

CFTC Amends Registration Exemptions for Private Fund and Mutual Fund Advisers

On February 9, the Commodity Futures Trading Commission announced it had issued a final rule rescinding and modifying certain registration exemptions for advisers to private funds and advisers to registered investment companies that trade in derivatives.

Section 4.13 of the CFTC’s rules provides exemptions from registration as a commodity pool operator (CPO) or commodity trading adviser (CTA). Section 4.13(a)(3) exempts de minimis trading with certain sophisticated investors, and Section 4.13(a)(4) exempts advisers to pools with only sophisticated investors without regard to the level of trading.
The final rule rescinds the Section 4.13(a)(4) exemption as originally proposed, but retains the
de minimis exception in Section 4.13(a)(3).

Family offices are not exempt from registration under the final rule, although family offices that have obtained prior relief from registration may continue to rely on such relief.

Section 4.5 provides relief from registration as a CPO for advisers to certain regulated entities. The amendments to Section 4.5 apply specifically to registered investment company advisers, and modify the exemption and exclusion provisions for such advisers as follows:

  • The exemption will include an alternative trading threshold test based on the net notional value of a registered investment company's derivative positions;
  • The marketing restriction no longer contains the clause "or otherwise seeking investment exposure to";
  • Annual notices for exemptions and exclusions will be filed on a calendar year-end basis and not annually on a filing anniversary; and
  • The registration Forms CPO-PQR and CTA-PR have been modified as well as the filing timelines.

Section 4.5 relief from registration is still available for banks, benefit plans, and insurance companies.

To remove certain ambiguities in the rule previously, the CFTC explicitly stated in the adopting release that it is the adviser’s obligation, not the fund’s, to register as a CPO. Requiring a board to register as a CPO "would raise operational concerns for the registered investment company as it would result in piercing the limitation on liability for actions undertaken in the capacity as director."

To rely on revised Section 4.5, mutual fund advisers may only post margin of up to five percent of the liquidating value of a mutual fund’s portfolio, after accounting for unrealized gains and losses. The alternative trading threshold test allows derivatives trading up to an aggregate net notional value equal to the full (100 percent) liquidation value of the fund, after accounting for unrealized gains and losses. While this test may allow a bit more flexibility than the margin test, "it may not be useful to funds investing in commodities through a controlled foreign corporation (CFC) because the rule treats the CFC itself as a fund and would measure notional value based on the NAV of the CFC," observed law firm Morgan Lewis.

Compliance dates.

Advisers no longer exempt from CPO registration as a result of the CFTC’s new rules have until December 31 to register. A companion rule proposal issued at the same time as the rule amendments addresses joint CFTC-SEC reporting requirements for advisers to registered investment companies. Should a rule be adopted prior to the end of this year, advisers no longer eligible to claim relief under Section 4.5 would have until the later of December 31 or 60 days after the adoption of the rule to register.
The final rule also rescinds the relief from the certification requirement for annual reports provided to operators of certain pools offered only to qualified eligible persons under Section 4.7(b)(3).

ACA Compliance Group offered a calculation of additional compliance dates related to the rule amendments:

By November 29, large CPOs with gross assets under management of at least $5 billion must file their initial quarterly report on Form CPO-PQR.

By March 1, 2013, large CPOs with gross assets under management of at least $1.5 billion but less than $5 billion must file their initial quarterly report on Form CPO-PQR.

By March 31, 2013, mid-size and small CPOs with gross assets under management of less than $1.5 billion must file their initial quarterly report on Form CPO-PQR.

Also by March 1, 2013, advisers relying on exemptions from registration as a CPO or CTA must file their annual certifications of such exemption from registration.

Nuts and bolts.

Registration as a CPO will require some time and effort, and estimates range from a minimum of two months to upward of six months.

The new CPO will be subject to CFTC and National Futures Association (NFA), the commodities industry SRO, registration and regulations.

The CPO must register on Form 7-R, and each principal and any associated persons must register on Form 8-R. Part of the registration process for principals and associated persons is passing certain examinations, such as the Series 3 or 31. Some advisers may also be subject to CTA registration, observed Morgan Lewis, if they are currently exempt under Section 4.14(a)(8) because they are not CPOs by virtue of the Section 4.13(a)(4) exemption that is being rescinded.

Commodities regulation requires a comprehensive compliance program with its own written policies and procedures.

Other compliance obligations of CPOs include:

  • Quarterly investor reporting;
  • Annual and quarterly NFA regulatory filings;
  • Annual audits of the commodity pool and submission of the audit reports to the NFA;
  • Initial and periodic ethics training for associated persons;
  • Annual self-examination;
  • Periodic examination by the NFA;
  • Books and records maintenance;
  • Registration and other filing fees; and
  • Fingerprinting of certain personnel.

Law firm WilmerHale noted that "most advisers currently relying on the exemption in Rule 4.13(a)(4) would be eligible to rely on CFTC Rule 4.7," Rule 4.7 provides relief from certain recordkeeping, reporting, and disclosure requirements where the private fund offers its interests solely to "qualified eligible participants."

The rule amendments were originally scheduled for action during an open meeting, but CFTC commissioners moved in writing to approve the rule changes 4-1. The lone dissenter, Commissioner Jill Sommers, cited a lack of appropriate cost-benefit analysis in her dissent, noting that the rulemaking far expanded an NFA petition related only to reinstating certain operating restrictions that had been in Section 4.5 prior to 2003.